After years of pegging their currency to the U.S. dollar, China has announced that it will allow the yuan, also known as the renminbi, to appreciate gradually over time by about 2 percent against the U.S. dollar. The small appreciation in the yuan will tend to make Chinese exports slightly more expensive and Chinese imports slightly less expensive.

This first round of appreciation will not likely have any major impact on world markets. The initial 2 percent change represents an important first step toward flexible exchange rates for China, but actually only results in shifting the value of the yuan from 8.11 yuan to the dollar to 8.28 yuan to the dollar-a change of only about 2%. This minor adjustment won't have any significant effect on Chinese trade with the rest of the world.
"Today's change is so minor that it will have no impact on the U.S. trade deficit, and it won't result in significantly higher prices at Wal-Mart," said Andrew Rothman, a strategist at CLSA Asia-Pacific Markets in Shanghai.

Nevertheless, the move toward flexible exchange rates is welcomed by China's trading partners. "I welcome China's announcement today that it is adopting a more flexible exchange rate regime," Treasury Secretary John W. Snow said in a statement. "As we have said, reform of China's currency regime is important for China and the international financial system."

"My feeling is that the (Chinese) leadership would really like to take the politics out of the relations and return to a more pragmatic atmosphere," said Jia Qingguo, a Peking University scholar whose specialty is the United States. "I don't expect that this one step will resolve the tension completely. But I think once the first step is taken, it will be easier to make currency adjustments later on. I think the key point is that China is willing to be flexible."

Although the timing was a closely guarded secret, China's recent revaluation did not come as a surprise. The United States and Europe have been placing pressure on Beijing to increase its currency's value because China has been accumulating a growing trade surplus with the U. S., Europe, and many other countries. In the end, outside pressure on China may have been the deciding factor in the gradual revaluation of the yuan. "I think the tendency was to move slowly and delay the decision," said Fred Hu, a managing director of Goldman Sachs Asia. "But China is acutely sensitive to U.S. concerns and is eager to placate Washington. On the margins, American pressure made the difference."

Questions

1.

Explain the effect of China's revaluation on its imports and exports.

2.

Discuss the concept of pegging one currency to another.

3.

Define currency appreciation and depreciation and differentiate these concepts with currency revaluation and devaluation.